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Corporate Bonds (Credit ratings (Two main credit rating agencies for…
Corporate Bonds
Credit ratings
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Agencies assign credit ratings based on a company's ability to repay its particular bond debt at maturity relevant to the particular bond issue and also the ability to service interest payments as they fall due
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Credit rating is now analogous to credit quality which is a measure of the issuer's ability to service its liabilities in terms of interest payments, coupons and repayment at maturity
In addition to their own personal knowledge and skill potential investors can use the ratings assigned by the main credit rating agencies
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It is the issuing company that pays these rating agencies to rate their bonds so this does create a potential conflict of interest
The ratings are used by banks and managers of investment funds when determining whether to include such a bond within a portfolio
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Companies whether established or start ups, may need to raise long term debt capital for any number of reasons and may achieve this in a number of ways
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Bank borrowing by way of loans - they will be subject to the banks terms and conditions, interest rates set by the bank and the possibility of a loan being recalled
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High yield bonds
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Even though the perceived credit risk of such bonds is far greater, it does not follow that the issuer will actually default and they are prospects of good returns for prudent investors
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When an investor purchases corporate bonds, they are in effect making a long term loan to company
It is essential to look at the specific bond prospectus in relation to each issue and it must be remember that an issuer may have many issues simultaneous
For investors corporate bonds are an attractive proposition as they provide fixed coupons and the promise of return of capita
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Although they are available to both individual and institutional investors, the level of skill and understanding required is not on par with that for derivatives
There is less risk than with ordinary shares in the same company however investors will not receive any equity in the company
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Bondholders have only a right to receive regular coupon payments and a return of capital at maturity; they have no rights in relation to the company and have no control over it
After the bond has been issued, the company is only concerned with making coupon payments as and when they fall due and the repayment of capital at maturity
The company may receive more or less than the face value of the bond, less if bonds are issued at a discount
The credit rating is applicable to a particular bond issuer and some bonds have no rating and such ratings are only provided at the request of the issuer
If a company enters into liquidation, bondholders are paid out before ordinary shareholders. However if there are no fund remaining, not even the bondholders will be paid
When the global economy entered into recession in 2007/2008 the risk of corporate default increased significantly and the prices of corporate bonds tended to fall. As more companies defaulted this had a domino effect on the bond prices of other companies. As investors offloaded their holdings of even investment grade bonds, where there was only a small chance of default. These bonds could be bought in the secondary market at bargain prices, and a situation arose where corporate bonds with good yields, but with prices considerably below par value, provided alert and less risk- averse investors with some excellent opportunities. These investors reaped their rewards as they earned not only a very decent return but also good capital growth.
The price of a corporate bond depends on the bonds credit rating combined with various market factors
If bought in the secondary market, the bond's yield to maturity should always be considered
The majority of bonds are not traded on exchanges although in the USA some corporate bonds are listed on an exchange while in the UK both buying and selling prices are available through the LSE
OTC instruments and can be traded anywhere in the world. They tend to be traded over the telephone and through computer links
Specialised bond dealers will make a market in the bonds quoting both buying and selling prices. Within each bond dealing firm there will be any number of traders who buy and sell to both the institutional and retail markets
Both dealers and brokers make their profits on their spreads, which can be wide, especially on corporate irredeemable bonds
Settlement takes place through CREST, Euroclear and Clearstream
